Enigma of Low Oil Prices

8/14/2019 Enigma of Low Oil Prices

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Oil is one commodity that has the potential to create or destroy wealth of

billions of citizens in the world. The problem is like energy, wealth can

neither be created nor destroyed but can only change the form. When the oil

price is high the wealth of the producing countries citizens increase manifold

at the cost of the consuming citizens of the world. The reverse is always true

when the oil prices are low. Can both live in harmony? Is there a win-win

situation? This is the context of my argument in this article.

To set the context right we need to understand the problems of high oil

prices and the cheap oil prices with some implications. This will lead us to a

solution to a better world of energy production and consumption.

Only a month back, we were bemoaning the high prices of oil. The

doomsayers are out predicting oil prices at $200 with extreme strains on

large sectors of economy in various countries. Today oil at over $40 a barrel,

costs less than one liter of water that we buy in India. Prices that low and

their equivalent at the pump will no doubt be viewed as a blessing by many

hard hit consumers. Here, however, is a simple but crucial reality no matter

how much it costs, whether its rising or falling, oil has profound impact on

the world we inhabit.

Good or bad times, oil will rule supreme and will continue to occupy the

largest share of the worlds energy demand. For all the talk of alternatives,

petroleum will remain an irreplaceable source of energy for at least the next

several decades. As per recent estimates of the Planning Commission, oil

and gas compensates for 38% of energy demand in India and is likely to

increase in the next few decades. A similar pattern holds for the planet as a whole:

Although bio-fuels and other renewable sources of energy are expected to play a growing role in

the global energy equation, don't expect oil to be anything but the world's leading source of fuel

for decades to come.


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Keep your eye on the politics of oil and you'll always know a lot about what's

actually happening on this planet. Low prices, as at present, are bad for

producers, and so will hurt a number of countries, including Venezuela, Iran,

Russia, Mexico, Nigeria, and Saudi Arabia, which could experience internal

unrest as oil revenues, and so state expenditures, decline. These countries

with windfall oil revenues have splurged their money in defense build-up to

meet their political ends.

No less important, diminished oil prices discourage investment in complex oil ventures like

deep-offshore drilling, as well as investment in the development of alternative energy sources.

Perhaps most disastrously, in a cheap oil moment, investment in non-polluting, non-climate-

altering alternatives like solar, wind, and tidal energy is also likely to dwindle. In the longer term,what this means is that, once a global economic recovery begins, we can expect a fresh oil price

shock as future energy options prove painfully limited.

Clearly, there is no escaping oil's influence. Yet it's hard to know just what forms this influence

will take in the year. Nevertheless, here are three provisional observations on oil's fate -- and so

ours -- in the year ahead.

1. The Price of Oil will Remain Low Until it Begins to Rise Again: I know this soundsinsane. The price of oil has essentially dropped through the floor because of the collapse

of demand due to the onset of a staggering global recession. The contraction in

international demand has indeed been stunning. After rising to a maximum in April-May

2008, demand started falling by 100,000 barrels per day for the whole of 2008 globally.

This year the US Department of Energy predicts the global demand to fall by a far more

impressive 450,000 barrels per day. The first time in three decades that world

consumption will decline in two consecutive years.

Needless to say, these declines were unexpected. In the happy days, believing that

international demand would continue to grow, the global oil industry steadily added to

production capacity and was gearing up for more of the same in 2009 and beyond.

Indeed, under intense pressure from the Bush administration, the Saudis had indicated


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delayed are a $1.2 billion venture to restart the historic Damman oil field, development of

the 900,000 barrel per day Manifa oil field, and construction of new refineries at Yanbu

and Jubail. In each case, the delays are being attributed to reduced international demand.

In addition, most "easy oil" reservoirs have now been exhausted, which means that

virtually all remaining global reserves are going to be of the "tough oil" variety. These

require extraction technology far too costly to be profitable at a moment when the per

barrel price remains under $50. Principal among these are exploitation of the tar sands of

Canada and of deep offshore fields in the Gulf of Mexico, the Gulf of Guinea, and waters

off Brazil. While such potential reserves undoubtedly harbor significant supplies of

petroleum, they won't return a profit until the price of oil reaches $80 or more per barrel

-- nearly twice what it is fetching today.

With industry cutting back on investment, there will be less capacity to meet rising

demand when the world economy does rebound. At that time, expect the present situation

to change with predictably startling rapidity, as rising demand suddenly finds itself

chasing inadequate supply in an energy-deficit world. When this will occur and how high

oil prices will then climb cannot, of course, be known, but expect gas-pump shock. It's

possible that the energy shock to come will be no less fierce than the present global

recession and energy price collapse.

3. Low Oil Prices Like High ones will Have Significant Worldwide Political

Implications: The steady rise in the oil prices between 2003 to 2008 as much a result of

increasing demand to the perception that the energy industry is having difficulty in

bringing sufficient quantities of supply. Many analysts spoke of the arrival of "peak oil,"

the moment at which global output would commence an irreversible decline. All this

fueled fierce efforts by major consuming nations to secure control over as many foreign

sources of petroleum as they could, including frenzied attempts by Chinese and Indian

firms to gobble up oil concessions in Africa and the Caspian Sea basin.

With the plunge in oil prices and a growing sense of oil plenty, this dog-eat-dog

competition is likely to abate. A new ball game in the political reality is to be expected


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with the low prices. While competition among consuming states may lessen, negative

political conditions within producing nations are sure to be magnified.

Many of these nations, including Angola, Iran, Iraq, Mexico, Nigeria, Russia, Saudi

Arabia, and Venezuela, among others, rely on income from oil exports for a large part of

their government expenditures, using this money to finance health and education,

infrastructure improvements, food and energy subsidies, and social welfare programs.

Soaring energy prices, for instance, allowed many producer countries to reduce high

youth unemployment -- and so potential unrest. As prices come crashing down,

governments are already being forced to cut back on programs that aid the poor, the

middle class, and the unemployed, which is already producing waves of instability in

many parts of the world.

For example, Russia's state budget remains balanced only when oil prices stay at or above

$70 per barrel. With government income dwindling, the Kremlin has been forced to dig

into accumulated reserves in order to meet its obligations and prop up sinking companies

as well as the sinking ruble. The nation hailed as an energy giant is running out of money

quickly. Unemployment is on the rise, and many firms are reducing work hours to save

cash. Although Vladimir Putin remains popular, the first signs of public discontent have

begun to appear, including scattered protests against increased tariffs on imported goods,

rising public transit fees, and other such measures. The damage is profound for Gazprom,

Russias biggest company and the source of approximately one quarter of Government

tax income. The market value of the company has dropped from $350 billion to today at

$85 billion.

Plunging oil prices are also expected to place severe strains on the governments of Iran,

Saudi Arabia, and Venezuela, all of which benefited from the record prices of the past few

years to finance public works, subsidize basic necessities, and generate employment. Like

Russia, these countries adopted expansive budgets on the assumption that a world of $70

or more per barrel gas prices would continue indefinitely. Now, like other affected

producers, they must dip into accumulated reserves, borrow at a premium, and cut back

on social spending -- all of which risk a rise in political opposition and unrest at home.


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The government of Iran has announced plans to eliminate subsidies on energy, a move

expected to spark widespread protests in a country where unemployment rates and living

costs are rising precipitously. The Saudi government has promised to avoid budget cuts

for the time being by drawing on accumulated reserves, but unemployment is growing

there as well.

Diminished spending in oil-producing states like Kuwait, Saudi Arabia, and the United

Arab Emirates will also affect non-producing countries like Egypt, Jordan, and Yemen

whose economy depends on these producers.

All this is occurring against the backdrop of an upsurge in the popularity of Islam,

including its more militant forms that reject the "collaborationist" politics of pro-U.S.

regimes like those of Hosni Mubarak of Egypt and King Abdullah II of Jordan. Combine

this with the recent devastating Israeli air attacks on, and ground invasion of, Gaza as

well as the seemingly lukewarm response of moderate Arab regimes to the plight of the

1.5 million Palestinians trapped in that tiny strip of land, the stage is set for a major

upsurge in anti-government unrest and violence. If so, no one will see this as oil-related,

and yet that, in part, is what it will be.

Conclusion

In the context of a planet caught in the grip of a fierce economic downturn, other stormy energy

scenarios involving key oil-producing countries are easy enough to imagine. When and where

they will arise cannot be foreseen, but such eruptions are only likely to make any future era of

rising energy prices all that much more difficult. And, indeed, prices will eventually rise again,

perhaps some year soon, swiftly and to new record heights. At that point, we will be confronted

with the sort of problems we faced in the spring and summer of 2008, when raging demand and

inadequate supply drove petroleum costs ever skyward. In the meantime, it's important to

remember that, even with prices as low as they are, we cannot escape the consequences of our

addiction to oil.

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Enigma of Low Oil Prices